Taxes and implied cost of equity capital in the UK-an analysis of Real Estate Investment Trusts

Taxes and implied cost of equity capital in the UK-an analysis of Real Estate Investment Trusts

Taxes and implied cost of equity capital in the UK-an analysis of Real Estate Investment Trusts

The effect of taxation on the implied cost of equity capital (ICE) has been by necessity focused on tax paying firms. There are no studies investigate what happens to the cost of equity capital when firms change their tax status. The introduction of the Real Estate Investment Trusts (REITs) in the UK in 2007 has provided such setting. It allows estimating of ICE for the UK REITs both pre and post conversion to examine the relationship between taxation and the cost of equity capital using a significant change in taxation.This paper investigates whether the tax status of REITs has an effect on their ICE. This issue was empirically tested using ICE estimated by four different models.The results suggest that the REITs exemption from corporation tax is associated with a significant increase in their ICE for levered REITs after conversion date and the majority of the study’s independent variables are consistent with the existing literature.

Abstract

The effect of taxation on the implied cost of equity capital (ICE) has been by necessity focused on tax paying firms. There are no studies investigate what happens to the cost of equity capital when firms change their tax status. The introduction of the Real Estate Investment Trusts (REITs) in the UK in 2007 has provided such setting. It allows estimating of ICE for the UK REITs both pre and post conversion to examine the relationship between taxation and the cost of equity capital using a significant change in taxation.This paper investigates whether the tax status of REITs has an effect on their ICE. This issue was empirically tested using ICE estimated by four different models.The results suggest that the REITs exemption from corporation tax is associated with a significant increase in their ICE for levered REITs after conversion date and the majority of the study’s independent variables are consistent with the existing literature.